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Observations on Recent Productivity Developments in the US, EU, and China Robert J. Gordon, Northwestern University, NBE

Observations on Recent Productivity Developments in the US, EU, and China Robert J. Gordon, Northwestern University, NBER, and CEPR. Keynote Lecture Seventh Macroeconomic Policy Research Workshop on Productivity, Trade and Development, Magyar Nemzeti Bank and CEPR, Budapest, October 31, 2008.

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Observations on Recent Productivity Developments in the US, EU, and China Robert J. Gordon, Northwestern University, NBE

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  1. Observations on Recent Productivity Developments in the US, EU, and ChinaRobert J. Gordon, Northwestern University, NBER, and CEPR Keynote Lecture Seventh Macroeconomic Policy Research Workshop on Productivity, Trade and Development, Magyar Nemzeti Bank and CEPR, Budapest, October 31, 2008

  2. Grateful for Invitation,Privileged to be here • In the midst of a world economic crisis, it is a luxury for us to think about long-run economic growth issues in the US, EU, and China • Most of this talk will discuss new research results for the US and EU • My brief comments at the end about China are those of the educated amateur, motivated by a trip there a month ago

  3. Budapest: The Site of My Favorite Musical (courtesy of Zvi Griliches 1994) • She Loves Me is a musical and movie with a book by Joe Masteroff, lyrics by Sheldon Harnick, and music by Jerry Bock. • The musical is the fifth adaptation of the play Parfumerie by Hungarian playwright Miklos Laszlo, following the 1940 James Stewart-Margaret Sullavan film The Shop around the Corner and the 1949 Judy Garland-Van Johnson musical version In the Good Old Summertime. It would surface yet again in 1998 as the Tom Hanks-Meg Ryan feature You've Got Mail. The plot revolves around Budapest shop employees Georg Nowack and Amalia Balash who, despite being consistently at odds with each other at work, are unaware that each is the other's secret pen pal met through lonely-hearts ads. • The original Broadway production played in 1963, and the show enjoyed a West End production and award-winning revivals on each side of the Atlantic in the 1990s.

  4. Theme for U. S.: Slowest Potential Output Growth in History Since 1875 • Potential Output of Interest Separately from Productivity because it matters for: • LR government budget & Social Security • World balance of saving and investment • US as an economic engine for the world • LR US demand for investment, residential housing, infrastructure

  5. The Slowest PotentialOutput Growth in U. S. History • Potential Output = Trend Output = Y* • Until recently it was common for forecasters to project Y* growth at 3 to 3.5 percent, some even projected 4 percent • Yet the facts provide an unhappy reality • 1997-2008 actual Y growth only 2.75 • Trend growth currently 2.5 • (paper explains how to estimate the trend)

  6. What is CausingSlow Y* Growth • Commonly assumed that US Y* growth would slow due to less population growth • But so far, population growth has not declined • Instead, culprits are slower growth in productivity, hours/employee, and LFPR • Much of this paper develops methods and implements them to separate cyclical movements from underlying trends

  7. Three Goals of the Lecture for the U. S. • #1: Project US Y* 2008-2028 and its components: Y ≡ Y/H x H/E x E/L x L/N x N (this is the “output identity”) • #2: New interpretation of recent behavior of these components, esp. Y/H • #3: Develop techniques for separating trends from cycles and analyzing the cyclical behavior of the components

  8. Goals of the Second Section on Europe • Interpret the post-1995 Turnaround of EU vs. US Labor Productivity and Hours per capita • EU – US productivity growth turns negative • EU – US hours per capita growth turns positive • Why? Is there anything to the idea of a tradeoff between productivity and employment?

  9. Thinking (briefly) about China • Issues in discussing Chinese Q/A growth are very different • I’m no expert but can read • Issues from my reading • Measurement: Level and Growth Rate • Sources of Growth Decomposition • Explaining the Puzzles • Can Capital per worker grow so fast in future? • Why is TFP growth so much faster than in India or rest of East Asia?

  10. General Issues Raised by Projections for the U. S. • The need to make future projections of e projections of Y* raises a general issue: how much of the past is relevant? • We project future population assuming that baby boom of 1947-64 will not happen again • We assume Great Depression and WWII will never happen again • But what is the right time horizon to look backward at productivity growth? • US: fast 1947-72, slow 72-95, fast 95-2004, then ???

  11. Topical Issues Achieved with this methodology • Separate all components of “output identity” into trend, cycle, and residual • Were “jobless recoveries” of 1991-92 and 2001-03 unusual? • Was fast productivity growth 2001-03 just a repeat of 1991-92? • What has been going on in 2007-08? Does employment lead output?

  12. To begin: History of U.S. Growth in Y* • Can’t Use Statistical Trends like H-P • Distortion in Great Depression and WWII • Standard HP quarterly parameter of 1600 implies that Y* growth declines from +3% in 1929 to minus 7% per year in 1933 • Solution: calculate log-linear trends between benchmark years 1875, 1891, 1901, 1913, 1928, 1950, and 1954. • Post-1954 trends taken from research reported later • See Table 1 in your handout

  13. Trend Real GDP Growth between Benchmark Years

  14. Questions about This History • The most dramatic episodes are slow growth 1913-28 and fast growth 1928-50 • Contradicts real business cycle theory about Great Depression • Raises puzzle about 1913-28, a dynamic period when electricity was applied in manufacturing • Otherwise stable growth 1975-1913 and 1950-72, then steady slowing down

  15. Using the “Output Identity” to Link Income per Capita to Productivity • (1) Y = Y/H * H/E * E/L * L/N * N • Four of five of these exhibit procyclical behavior (not population 16+) • BUT concept of productivity usually discussed in U.S. is for NFPB sector • This equation works as long as our data are for total economy productivity and total economy hours per employee.

  16. The Output Identity Allows us to . . . • Estimate trends in any of the variables, call x the log of a variable and x* its trend • Δx is the growth rate of the actual value and Δx* is the growth rate of the trend • Δ(x-x*) is the growth rate of the ratio of actual to trend for any variable • We estimate regressions with Δ(x-x*) as the dependent variable for four components of the output identity (excluding population)

  17. Simplest Method to Measure Trends: TTB Method • TTB is log-linear Trends through Benchmark quarters • Quarters are those when unemployment roughly equal to the natural rate (down, not up) • Turn to Table 2, shows 7 periods • This is our first introduction to the question – why doesn’t growth in Y/N equal historical growth in Y/H?

  18. Some of What We Learn from Table 2 • Real GDP growth slowed down as in Table 1 and the chart • The five components must add up to real GDP growth by definition • Productivity growth soared after 1995 but real GDP continued to slow down • Hours per employee were strongly negative in 2 periods, moderately negative in 2 periods, near zero otherwise • Employment rate barely moves, by assumption

  19. More About Table 2 • LFPR rose strongly 1964-87, not since then (this pulls down growth in Y/N relative to Y/H since 1987) • Working-age Population growth peaked before 1977 but held up relatively well 1997-2007

  20. Simplify by Combining Terms • Turn to table 3 • Now compare annual growth rates in Y/N and Y/H for the same time intervals • By definition any discrepancies must be equal to three labor market variables • Labor-market variables explain changing relationship between growth in Y/N and Y/H • Next slide presents the numbers of Table 3

  21. How Y/N Grows Differently than Y/H

  22. Next we turn to resultsof statistical trends • Hodrick-Prescott filter • Bends too much at standard parameter of 1600 • We use parameter of 6400, even that bends too much • Kalman filter • Allows feedback from other variables, we allow feedback from GDP Δ(x-x*)

  23. TE Productivity Trends: TTB vs. Kalman

  24. Kalman Trend vs. Actual 8-Quarter Changes

  25. Actual/Trend Total Economy Productivity Raises Questions

  26. The Mysterious Behavior of Trend TE Hours/Employee

  27. The Trend Employment Rate (E/N): Nothing Happens

  28. Trend for LFPR: The Women Entered but Now?

  29. Population Growth: No Business Cycles but it Matters in Future Forecasts

  30. Adding Componentsfor Real GDP

  31. Conclusion About Real GDP Trend • Slowdown from 4.4 in early 1960s to 2.5 now • Viewed over decades, productivity growth is negatively correlated with labor force growth • Hours per Employee and LFPR • Population Growth Decline has barely started

  32. How do Components React to Changes in Output Gap?(revisiting Okun’s Law) • First method in Table 4, look at cyclical deviations in quarters that have peak and trough deviations for Q • Then Tables 5 and 6, regressions of components of output identity

  33. Specification of Regressions • Dependent variables are first differences of ratios of actual to trend • Δx’t = Δ(xt – x*t ) • Table 5: H/E, E/L, L/N • Table 6: Aggregate H, Y/H • Specification: Δx’t = Σαi Δx’t-1 + Σβj Δy’t-j + φx’t-1 + ΣγkDk + εt

  34. Skip over Table 5,Look at Table 6 • Shown are sums of coefficients • ** indicates significance at 1 percent, * indicates significance at 5 percent • Note significance of EOE dummy variables • Bottom of table shows EOE coefficients when they are all forced to be equal • Column 2: dependent variable is productivity rather than aggregate hours • Table 7 summarizes responses

  35. “Early Recovery Productivity Bubble” • Table 8 • Top panel shows change in productivity relative to trend in first four quarters of recovery • Bottom panel the next eight quarters (i.e., quarters 5 through 12) • On average 1.59 points vs. -0.11 points • Largely explained by equation, relying on response to output change and to EOE effect • Unusual about 2001-04, growth stayed above trend in next eight quarters

  36. Cumulative Equation Errors, 1985-2008

  37. Now the Explanations of Changes in Productivity Trend • 1995-2000 productivity growth revival, consensus that it was driven by production and use of ICT equipment • 2001-2003 further increase in trend growth • Savage corporate cost cutting • Intangible capital hypothesis

  38. Explaining the Two Hypotheses • Cost Cutting in 2001-03 • Employment declined until mid-2003 while output increased • Result: unusual upsurge of productivity • Profits had been propped up by accounting scandals, then collapsed • More of manager pay relied on stock options than 10 years earlier • Great pressure to revive profits and stock prices by cutting costs, leading to massive layoffs • Oliner-Sichel-Stiroh (2007 BPEA) support: cross-industry positive correlation profit decline and employment decline

  39. Complementary Intangible Capital Hypothesis • Benefits of late 1990s ICT investment was delayed • “Learning lag” in how to use ICT investment, development of software • Many of benefits of 1995-2000 ICT investment occurred with a lag in 2001-03 • Explains how output could grow with employment declining

  40. Why Productivity Trend Growth Slowdown 2004-07? • Profits revived, reducing pressure for cost cutting. Employment grew again • Intangible capital: delayed benefits of 1995-2000 investment boom gradually ended • ICT investment did not revive; returned to pre-1995 values as share of GDP

  41. Why Did Productivity Grow Faster than Trend 2007-08? • Employment declined slowly and steadily January, 2008 until now • Real GDP grew in first half 2008, news yesterday of -0.3 percent real GDP 08:Q3 • Strong productivity growth, but temporary • GDP growth in early 2008 represents shift to exports • Capital intensive, high productivity • Composition effect, exports of commodities use little labor

  42. Back to Original Topic:Future Growth in Potential Output • Key assumptions: population growth, productivity, hours per employee • No assumed change in employment rate or LFPR • Assumed TE Productivity growth 1.6 vs. 1.7 for last 21 years • Result: 2.40, the slowest in American history

  43. End Result: Projections over 2008-2028

  44. Turning to Europe: The Employment – Productivity Tradeoff (CEPR DP 6722 2/08) • EU labor productivity catches up to US level up to 1995 then falls back • Hours worked moves in the opposite direction • Did one cause the other? • Major increase in heterogeneity • Understanding these issues will help us understand the effects of changes in policies and institutions

  45. Main Contribution is to the Policy Debate • For 20 years, Europe had low employment and hours, high unemployment • Post-1995 Turnaround: Slower growth productivity and faster E/N • EU wants to change it all with reforms – some to raise employment, others to raise productivity • You Can’t Have It Both Ways

  46. Trend TE Productivity Growth: US vs. EU-15

  47. Trend Growth in Hours per Capita, US vs. EU-15

  48. Output per Capita (Y/N) Growth: Almost the Same

  49. The Employment-Productivity Tradeoff • Take any CRS production F(K,L) Y/L=f(K/L) • As long as capital is fixed, an increase in employment lowers labor productivity • We don’t know how fast capital adjusts; the tradeoff may be quantitatively small • A major goal of this research is to quantify the tradeoff

  50. Turnarounds in Hours and Output • Turnarounds are 1995-2006 minus 1980-1995 growth • The relative turnarounds (EU minus US) cancel each other out Y/H + H/N = Y/N -2.20 1.99 -0.21 • 1980-2006 Y/N growth is identical • But the EU is not catching up in level of Y/N relative to US

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